Friday, October 19. 2012 - Sometimes I Forget What I'm Supposed To Remember

Sometimes I Forget What I'm Supposed To Remember

by Sinclair Noe

DOW – 205 = 13,343
SPX – 24 = 1433
NAS – 67 = 3005
10 YR YLD -.06 = 1.77%

OIL – 1.96 = 90.14
GOLD – 21.10 = 1721.50
SILV - .75 = 32.17
PLAT – 29.00 = 1625.00

Today is the 25^th anniversary of Black Monday, and the markets paid homage with a 205 point drop, nothing close to the 508 point drop in 1987. On a percentage basis, 1987 was 16 times worse than today. The Crash of 1987 would be about a 3,100 point drop in today's markets. That would get your attention. Still, the more things change the more they stay the same.

Back in 1987, the Crash was blamed, at least in part, on program trading, based on portfolio insurance and a process called dynamic hedging. I remember computers back then that weren't fast enough to play Pong, much less cause a crash. Maybe the Wall Street crowd had really fast floppies. Today we have high frequency trading or HFT, and they can whip out trades in milliseconds; and if you're looking for a market crash in the future, don't be surprised if it comes from HFT. The whole idea of HFT is legalized theft and it doesn't add to market liquidity, stability or efficiency. They are not market-makers. They are market-manipulators. They have no obligation to make a market in any stock. The never have to post a market or ever honor the bids and offers they post. In fact, their game is to post fake bids and offers that they have no intention of honoring.

High-frequency traders send out tens of millions, if not billions, of orders to exchanges that are never meant to be executed. They are fake orders designed to manipulate prices on the nation's exchanges. And while other market participants are not actually forced to adjust their bids and offers or engage in any of these trades, allowing access to the exchanges to manipulate anybody in any way is something that ought to be outlawed. The main advantage of HFT is that the traders are fast and they are so fast they can jump in front of your trade and skim off a tiny fraction

The SEC allows exchanges to serve high frequency traders by leasing them co-location space next to the exchange's servers. It's kind of like allowing pickpockets to come into the bank and stand at the tellers' window and steal from the customers, as long as they only steal pocket change and not folding money. The problem is that all that pocket change adds up the real money. HFT activity is responsible for at least half of the daily 6.8 billion shares traded across America's exchanges, and may be as much as 80% by some measures. And when HFT accounts for more than 50% of trades it means the high frequency traders are playing with themselves. This means liquidity is an illusion.

Remember the Flash Crash of 2010? The Dow dropped 1,000 points in 10 minutes. Remember the Knight Capital fiasco a few months back? Remember Kraft Foods a few weeks ago? A computer algorithm has a minor glitch and in the blink of an eye tens of millions of dollars is wiped out; trillions could vanish in the time it takes to stir your coffee. So, do you trust the stock market?

The problem today was largely blamed on earnings. Of the 116 S&P 500 companies that have reported results so far, 58 percent have missed on revenue expectations. Note, we're not talking about bottom line profits, we're talking top line revenue; and in some ways that is far more frightening. Today it was GE, McDonald's and Microsoft. Yesterday it was Google, with premature earnings. Google is groping for ways to grow revenue. That puts Google in the same position as Microsoft, trying to find a way to extend its reach.

Google and Microsoft together have over $100 billion of cash on their balance sheets. Judging by the earnings misses that both turned in last night, Google and Microsoft are both willing to take a step back on earnings to invest in the "next big thing." The question for investors is whether or not either or both companies can find that elusive second act. The problem is not the prowess and expertise of these two high tech giants. They continue to create and refine. The problem is demand. We've seen it before.

Remember back in the 80's when Japan was known for its electronic prowess? In 1990 Japanese products represented nearly 30% of the world's total export value. Now that figure is closer to 14%. Remember back in the 80's when the Japanese started an aggressive expansion, buying up all things American. Now, they're on the hunt for growth anywhere they can find it and in any sector that grows. For example: Talkeda Pharmaceuticals has been on a $15 billion buying binge, scooping up Swiss, Brazilian, and a couple of US companies. Daikin Industries just spent nearly $4billion to buy the US airconditioning manufacturer, Goodman. In the financial services sector, Mitsubishi UFJ Lease and Finance is purchasing Jackson Square Aviation for $1.3 billion.  Tokio Marine & Nichido Fire Insurance bought Delphi Financial Group last year for $2.7 billion. And earlier this week, Softbank said it would purchase a 70% stake in Sprint Nextel for $20 billion. That's the biggest M&A deal of the year.

Japanese companies have more than $2 trillion in cash on their balance sheets and some very powerful motivation. The Japanese economy is lousy; the demographics are old; private, corporate, and government debt is 500% of Japanese GDP; and Japanese companies just can't seem to drum up business in Japan.

Of course, back in 1987, the economy recovered pretty quick after the Crash. I don't think that would happen today. The main reason is that the financial sector has changed. Back then we had traditional banks and there were investment banks; and there was a brick wall between them. Back then we had Glass-Steagall. We should resurrect it. It was good policy.

Five years ago Wall Street’s excesses almost ruined the economy. Bankers, hedge-fund managers, and private-equity traders speculated on the upside, then shorted on the downside — in a vast zero-sum game that resulted in the largest transfer of wealth from average Americans to financial elites ever witnessed in this nation’s history.

Average Americans lost big; including over $7 trillion of home values, a $700-billion-dollar bailout of Wall Street, and continuing high unemployment. The top one-percent, the financial elites made out fine. The rich get richer and the poor get poorer; maybe some things never change. The stock market has about caught up to where it was before the crash of 2008; this time it was a far different rebound than the rebound following the Crash of 87. The pay and bonuses on the Street are once again sky-high. So are the pay and perks of top corporate executives. This country has had a hard row to hoe, but some folks have made out like bandits. The problem is that there just aren't enough of them to increase demand. That should be one of the lessons we learned from the Japanese.

In the 1980s the ten biggest banks had less than 30 percent of bank depositary assets. Now they have 54 percent. And the four biggest now dominate the Street almost completely. Because lenders and investors know they’re too big to fail, the four biggest banks have a competitive advantage over smaller rivals that pose larger financial risks. That means they’ll only get bigger.

Breaking up the biggest banks and capping the size of all banks is hardly a radical suggestion these days. There's a long list who think we should. We need to restore trust to Wall Street, and that means we should outlaw the High Frequency Trading bandits; that's one of the lessons we should have learned back in 1987. We need to break up the biggest banks and resurrect Glass-Steagall. That's one of the lesson we actually learned back in 1929. And then we forgot it. "Those who cannot remember the past are condemned to repeat it.”